You are given the following continuously compounded forward rates: 00.2= 6.5%, 02,3 8.0%, 072,4- 8.0%, andor2,5=...

 

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You are given the following continuously compounded forward rates: 00.2= 6.5%, 02,3 8.0%, 072,4- 8.0%, andor2,5= 8.0%. You also know that Bond A, which matures at the end of year 5 and pays $10 at the end of year 1 through year 5, has a face value of $100. Its price is $109.76782. (a) Compute the forward rate of 1,3 (b) Assume the price of a 1-year zero remains the same as in the previous part. If the forward rate of 2,3 is now 7.4% instead of 8.0%, is there an arbitrage opportunity? What would be your investment strategy and how large of a profit can you make buying or selling one unit of Bond A? Assume you can buy or sell zero coupons. You are given the following continuously compounded forward rates: 00.2= 6.5%, 02,3 8.0%, 072,4- 8.0%, andor2,5= 8.0%. You also know that Bond A, which matures at the end of year 5 and pays $10 at the end of year 1 through year 5, has a face value of $100. Its price is $109.76782. (a) Compute the forward rate of 1,3 (b) Assume the price of a 1-year zero remains the same as in the previous part. If the forward rate of 2,3 is now 7.4% instead of 8.0%, is there an arbitrage opportunity? What would be your investment strategy and how large of a profit can you make buying or selling one unit of Bond A? Assume you can buy or sell zero coupons.

Answer rating: 100% (QA)

a Forward rates are 1 year 736 2 years 744 3 years 752 4 years 760 ... View the full answer